July 5,2019:

The Author, Tanvi Sapra is a 2nd year BA.LL.B student of Vivekananda Institute of Professional Studies, GGSIPU, Delhi. She is Currently interning with Latestlaws.com.

Critical Analysis of Role of Arbitration in Petroleum and Gas Industry By Tanvi Sapra (Download PDF)

INTRODUCTION

India is one of the fastest growing major economies in the world and the third largest consumer of petroleum products, after US and China. Although there is an increased focus on gas and renewables, demand for oil has always been on the rise, and is estimated to grow at least until 2040. As per the report published by India Brand Equity Foundation (IBEF), India’s energy demand is expected to double to 1,516 million tonnes of oil equivalent by 2035 from 723.9 Mtoe in 2016. Moreover, India’s share in global primary energy consumption is projected to increase by two-folds by 2035.

India is the fourth-largest Liquefied Natural Gas (LNG) importer after Japan, South Korea and China, and accounts for 5.8 percent of the total global trade (IBEF, published in October, 2017). India has always been an import dependent nation in the Oil and Natural Gas (“O&NG”) sector. Due to this increased reliance, the disputes also increase.

Disputes in the oil and gas sector could arise as a result of environmental claims; shareholder value related issues, regulatory issues, trade restriction among others.  Contracts in the oil and gas industry more often do involve individual foreign parties.  It could be an individual, an agency representing a state or even a NOC.

Recourse to a national court to address any contractual disputes between these parties would mean that, the national court would be a foreign court to the other party. These courts have their own rules; formalities and procedure designed to deal with domestic issues and may not have the competence and experience to handle complex international cases.  The language of these courts may not be the language of the contract and hence cannot be used to settle such international energy disputes.

Any international contract signed by the parties that does not contain an arbitration clause will have recourse to foreign court systems to resolve their disputes. However, if the parties to an agreement provide for an arbitration clause, the parties will have the opportunity of resolving any disputes that may arise in future on a neutral ground rather than on the home grounds of one party or the other.  Since most oil and gas contracts are international in nature, International Arbitration fits in as the best alternative to addressing any contractual disputes that may arise because it gives the disputants the opportunity to participate in the nomination and appointment of the arbitral tribunal for their dispute.

One popular example of an International Arbitration case was the Arabian American Oil Company (Aramco) case.  The Saudi Arabian government in 1933 signed an agreement with Aramco; in the contract agreement, Aramco was given the exclusive right to extract and transport oil from its concession block within Saudi Arabia. Later in 1954, another agreement incongruent to the initial one (Aramco agreement) was entered into between the government of Saudi Arabia and Saudi Arabian Maritime Tankers Ltd. The dispute was finally resolved by arbitration in Geneva, 1955

THE LEGAL FRAMEWORK IN INDIA RELATING TO PETROLEUM AND GAS INDUSTRY

The main laws affecting the Oil and Natural Gas Industry have been explained below.

  • The Petroleum Act, 1934: This act regulates the import into India, transfers within, storage, production, refining and blending of petroleum and deals substantially with midstream activities.
  • The Oilfields (Regulation and Development) Act, 1948: This act constitutes the basic statute for licensing and leasing of petroleum and gas blocks by Government of India, empowering the same with broad authority to make rules providing for the basic regulation of oilfields and for the development of mineral oil resources. Along with Petroleum Rules, the Oilfields Act governs the grant of Production Exploration Licenses and mining leases.
  • The Petroleum and Natural Gas Rules, 1959: These rules provide a framework for grant of exploration licenses and mining leases, and together with the Petroleum Act, 1934, regulate the sale and distribution of petroleum and petroleum products.
  • The Petroleum and Natural Gas Regulatory Board Act, 2006: This act provides for the setting up of the Petroleum and Natural Gas Regulatory Board to regulate the refining, processing, storage, transportation, distribution, marketing and sale of petroleum, petroleum products and natural gas (excluding production of crude oil and natural gas).
  • NELP: NELP was formulated by Government of India and the Directorate General of Hydrocarbons (“DGH”) as the nodal agency in 1997-98 to provide a level playing field to both public and private sector companies in E&P of hydrocarbons, though NELP is not a law by itself and is not passed in exercise of any rule-making powers. NELP promotes investments in E&P Sector by facilitating allotment of exploration blocks through international competitive bidding. Although the NELP regime was successful in the early days, NELP VIII and IX are often criticized for its failure to attract widespread participation by large international oil and gas operators and since 2009, and it has been the endeavour of Government of India to change the model. NELP has now been replaced by HELP.
  • Hydrogen Exploration and Licensing Policy (HELP): HELP aims to enhance domestic oil and gas production by encouraging exploration in sedimentary basins, and introduces a number of measures including a uniform license regime for conventional as well as non-conventional hydrocarbons, an open acreage licensing policy, a revenue sharing model and freedom in marketing and pricing (subject to certain limits).
  • Various Taxation Laws

DISPUTE RESOLUTION

The Constitution of India is the supreme law of the land and the fundamental source of law in India. The Constitution gives due recognition to statutes, case law and customary law. India has a single unified judicial system. The Supreme Court is at the apex of the entire judicial system followed by High Courts in each state or group of states. There is a hierarchy of subordinate courts below each state’s High Court. India is a secular society and has adopted common law concepts into its legal system. It has codified and uniform commercial codes that include contract law, corporate law, exchange control regulations, etc.

The Industrial Policy, naturally, is coloured by the political philosophy of the government in power and finds expression in the form of policy pronouncements, press notes and notifications under the Industries (Development and Regulation) Act and cognate legislations such as the FEMA, Competition Act. Foreign judgments and arbitral awards are enforceable in India owing to the express provisions contained in the Civil Procedure Code, 1908 and Arbitration and Conciliation Act, 1996.

India’s Arbitration and Conciliation Act, 1996 provides a statutory framework for the enforcement of foreign arbitral awards given in countries that are signatories to either the 1927 Convention on the Execution of Foreign Arbitral Awards (Geneva Convention) or the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention). A foreign judgment can be enforced in India in one of two ways:

  • judgments from courts in ‘reciprocating territories’ can be enforced directly by filing an execution decree. before an Indian court; and
  • judgments from ‘non-reciprocating territories’, such as the United States, can be enforced only by filing a lawsuit in an Indian court for a judgment based on the foreign judgment. The foreign judgment is considered evidentiary. The time limit to file such a lawsuit in India is within three years of the foreign judgment.

There are a number of statutes that have anti-corruption and anti-bribery provisions such as the Indian Penal Code, 1860 (IPC), Prevention of Corruption Act, 1988, Prevention of Money Laundering Act, 2002, Right to Information Act, 2005, Central Vigilance Commission Act, Lokayukta Acts of states, etc. India recently enacted the Lokpal and Lokayukta Act, which is a landmark legislation aimed at combating corruption by creating an anti-graft ombudsman with broad powers to prosecute all offending politicians, ministers and senior civil servants, including the Prime Minister of the country. Key stated objectives of the new law are the more effective implementation of the United Nations Convention Against Corruption, which India has ratified, and the prompt and fair investigation and prosecution of cases of corruption. The legislation was adopted on the basis and in furtherance of India’s main anti-corruption law, the Prevention of Corruption Act, 1988.

Regulatory frameworks are the laws and regulations that outline the legal requirements to be met. They may also be complemented by policies, standards, directives and guidelines.

At present, the Ministry of Petroleum and Natural Gas (MOPNG) is in charge of regulating the upstream sector and the Director General of Hydrocarbons (DGH) performs technical advisory functions. The government is empowered under the constitution to make laws with respect to regulation and development of oilfields and mineral oil resources and petroleum and petroleum products. In exercise of these powers, the government has drawn up a comprehensive set of petroleum legislation that regulates and covers various facets of the industry.

The MOPNG is responsible for the administration of the petroleum legislation. The Oil Fields (Regulation and Development) Act, 1948 and the Petroleum and Natural Gas Rules, 1959 made by the government provide the regulatory framework for domestic exploration and production of oil and gas.

In April 1993, DGH was set up under administrative control of the MOPNG to promote sound management of domestic oil and gas resources, keeping in view the environmental safety, technological and economic aspects of upstream activities. In September 2006, the government designated DGH as the authority or agency under the 1948 Act to exercise statutory powers to carry out its functions.

The regulatory regime specific to the oil and gas industry constitutes primarily the Petroleum Act, 1934, the Petroleum Rules, 1974, the Petroleum and Natural Gas Rules, 1959 and the Oilfields (Regulation and Development) Act, 1948.

These statutes and rules lay down the substantive and procedural requirements to be complied with in order for a private party to engage in E&P, refining, import and distribution activities relating to petroleum products. In addition, the Petroleum Ministry, from time to time, announces various notifications and regulations, which govern the procedural and policy norms for the sector. The Territorial Waters, Continental Shelf, Exclusive Economic Zone and other Maritime Zones Act, 1976 provides for the grant of a licence by the government to explore and exploit the resources of the continental shelf and the Exclusive Economic Zone.

Changes in the legislative environment

The Indian judicial system is advancing progressively in the field of arbitration. In the last three years, India has seen a growth of nearly 200% in the number of disputes that have been referred to arbitration.

Arbitration disputes in India have been rampant in the construction and infrastructure, and oil and gas sectors. This is primarily due to the nature of these businesses and exigencies attached in running the business. Financial sector disputes are reported at an increasing rate in areas including private equity, joint ventures and mergers and acquisitions.

An award passed by an arbitral tribunal takes considerable time (around two to three years) to be enforced by Indian courts. However, with the reduction of court intervention in foreign seated arbitrations recently, it is anticipated that awards will be enforced proactively and at a faster pace.

With the aid of technology, heavy documentation can be segregated and indexed properly, thereby saving valuable time and effort. It can be made easily accessible to disputing parties across countries. The use of e-Discovery, financial modelling tools, data management systems, etc., in arbitration is expected to make the process time and cost effective. A mechanism developed for Online Dispute Resolution (ODR) may result in a viable and cost-effective dispute-resolution system.

An effective mechanism, implemented for effective fast-track arbitrations with reasonable time limits, and adhered to by parties would result in time-bound resolution of disputes.

Third-party funding is still in its nascent stage in India and its impact needs to be examined. The Indian Arbitration statute does not make explicit provisions relating to cost allocation of arbitration proceedings.

It is believed that the arbitration scenario in India will take a stride in a positive direction through implementation of cost and time-effective measures.

The oil and gas industry have proved to be a fertile ground for disputes and in particular for practitioners of international arbitration, given the cross-border aspects of exploration and production activities. Litigation in the O&NG sector is generally governed by rules of the relevant PSU which is awarding a contract or in the form of representations before an authority under the Ministry of PNG. Contracts with PSUs generally have an arbitration clause. However, before initiation of an arbitration, there are generally provisions for mediation and conciliation before the dispute resolution mechanism is invoked.

The arbitration typically takes the nature of an international commercial arbitration. In such instances, recourse to Indian Courts are limited albeit for interim protection under Section 9 of the Arbitration and Conciliation Act, 1996 (“Arbitration Act”) and the consequent appeal arising thereof under Section 37 of the Arbitration Act, or Indian Court’s assistance in recording of evidence under Section 27 of the Arbitration Act.

These provisions are invoked by the parties to litigate before Indian Courts in aid of the arbitration proceedings.

To cite an example: In Union of India v. Reliance Industries, the partial award passed by the Arbitral Tribunal was challenged under Section 34 of the Arbitration Act by the Government of India on the ground that subject-matter of the arbitration comprising of payment of royalty, cess, service tax and audit issues involved questions of public policy and therefore are non-arbitrable.

The Delhi High Court held that questions of arbitrability of claims cannot be tested only as per the applicable law of arbitration or Lex arbitri but needs to be analysed in accordance with the public policy and intention of parties governed as per laws of the country to which it has the closest connection. The ruling clarified that clauses of the agreement need to be read in a holistic manner to discern intention of parties and whether exclusion of Indian laws done for the purpose of governing arbitration could be extended if subject matter of the arbitration is non arbitrable. It is in this context that the Delhi High Court rejected the objections on lack of jurisdiction due to express choice of law provisions.

The matter was appealed in the Supreme Court by way of special leave petition, and on May 28, 2014, the Supreme Court held that Section 34 petition filed in Delhi High Court was not maintainable. Supreme Court also opined that when a final award is made, the enforceability of the same in India can be resisted on the ground of public policy. Supreme Court opined that the conclusion of the Delhi High Court that in the event, the award is sought to be enforced outside India, it would leave the Indian party remediless is without any basis as the parties have consensually provided that the arbitration agreement will be governed by the English law.

Recently, the Supreme Court after hearing the arguments of RIL for the appointment of a foreign tribunal chair to preside over a dispute concerning cost recovery at the two gas fields off the coast of Andhra Pradesh, against Union Govt., has appointed an arbitrator to adjudicate the dispute. In this arbitration, RIL claimed that its PSC with Union Govt. entitled it to recover fully the cost of developing the two fields before sharing profits, and the PSC contained no provisions for the Union Govt. to restrict cost recovery. The Indian oil company has a 60% interest in the two fields, Niko has a 10% stake and BP has a 30% stake. The parties had approached the Supreme Court because the two-party nominated arbitrator had failed to appoint the chair.

Further, even if there is a delay in appointment of an arbitrator pursuant to invocation of such a clause, the courts may be reluctant to appoint an arbitrator in view of the agreed upon dispute resolution mechanism. It is only when there is a refusal or unjustified delay in appointment of an arbitrator that the court will exercise jurisdiction under Section 11 of the Arbitration Act.

The cardinal principle that governs the approach of courts in construing such conflicting clauses is the rule of harmonious construction. In case of any conflict between multiple provisions, Indian courts generally strive to make the contractual arrangement workable in a reasonable and pragmatic fashion, by making good any omissions that can help make the contract workable. For instance, in the case of Enercon (India) Ltd & OR’s v Enercon GmBH & Anr (2014) 5 SCC 1, an arbitration agreement provided for a tribunal of three arbitrators to be appointed but delineated the procedure only for the appointment of two arbitrators. In such a situation, the Supreme Court held that, given that the parties’ intention to arbitrate was clear, the agreement had to be construed in such a fashion as to give effect to the intention of the parties, which is the governing consideration in all such cases.

IMPORTANCE OF ARBITRATION IN PETROLEUM AND GAS INDUSTRY

One of the reasons why arbitration is popular can be traced to the fact; the arbitral tribunal decision is recognized and enforced internationally.  Unlike litigation that the final decision by the judge could  be subject to an appeal, the decision by an arbitral tribunal is not only final and binding; it is also recognized and enforceable even at the international level, i.e. the enforcement does not only take place in the place where the award is made but also in any other country where the party against whom the award was made has his assets. The decision of the arbitral tribunal in this case becomes a substance of acceptance unlike mediation.

In a case that was internationally settled through International Arbitration was the nationalization phenomenon that was carried out in Libya on December 7, 1971, culminating into three sets of arbitration proceedings against the Libyan government.  The disputes were between government of Libya and British Petroleum (BP), Texaco Overseas Petroleum Company (TOPCO) and Libyan American Oil Company (LIACO).

A recent arbitration award enforced is the ICC ruling between Exxon Mobil and Petroleos De Venezuela, S.A.  (PDVSA-Venezuela NOC), regarding the 2007 nationalization of assets by the Venezuelan government, which awarded Exxon Mobil $908 million and finally was reduced to around $750million in favour of PDVSA; but in any case, the award was enforced and recognized.

Besides, privacy and its accompanying confidentiality that is enshrined in most arbitral proceedings makes International Arbitration more desirable to companies in the oil and gas industry relative to other Alternative Dispute Redressal Mechanisms. Disputes involving some trade secrets, intellectual property issues, high-technology information and other competitive practices are sensitive and vital such that parties may want to protect them so as to avoid their competitors from taking undue advantage of them. The only way to resolve a dispute away from media attention to be able to keep these business secrets is to resort to international arbitration.

Parties have the choice of selecting arbitrators that have the technical expertise and are experienced in their field of practice.  Arbitration is faster and less costly compared to litigation.  This has always been one of the fundamental arguments in favour of the arbitration.

In Visa International Ltd v Continental Resources (USA) Ltd [(2009) 2 SCC 55], the Indian Supreme Court dealt with a case in which arbitration was envisaged on a failure of the parties to settle the dispute amicably. Holding that the exchange of letters and correspondence between the parties was sufficient for satisfying this condition, the court held that conducting formal conciliation proceedings was not a precondition to the commencement of arbitration. Thus, while stepped arbitration clauses are common and enforceable in India, courts will analyse the facts of each case to determine whether requiring the parties to strictly follow the pre-arbitration steps would be fruitful or practicable. Moreover, notwithstanding the language of the dispute resolution clause in the model RSC and RC contemplating a binding decision to be passed by a sole expert, such a decision may not preclude a party from initiating arbitration proceedings after the sole expert’s decision is delivered.

Concerns are now being raised as to whether arbitration is indeed faster and cheaper compared to litigation. There is no any available evidence to prove the claim in one way or the other. What can however be said is that the disputants can comparatively have a faster arbitration at a cheaper cost if they so desire.

Limitations of International Arbitration

IA has its own shortcomings. Among the weaknesses of IA are: costs of arbitration, limited power of the arbitrators, the difficulty of bringing three or more parties before the same arbitral tribunal, delay sometimes due to the difficulty of communication and language and inconsistency. Fees and expenses of arbitrators, interpreters, translators, counsellors and their transportation are borne by the parties unlike the salary of a judge in the judicial system. These expenses could be substantial depending on the weight (amount involved) of the dispute in question.  Sometimes, the parties may be required to hire conference rooms for hearings and proceedings instead of making better use of public facilities of the national court system.

One other weakness of IA is that it delays sometimes.  An arbitral tribunal has to be constituted before the arbitration proceedings can commence. Delays are sometimes attributed to the difficulty of communication and language.

The arbitral tribunal would have to submit their decision for example to the ICC Court for the final award to be made and sometimes it takes months and even years for a final award to be enforced. It works well if the dispute involves two parties. For now, all the existing legal and institutional frameworks support disputes that are two sided i.e. a claimant and a respondent but there can be more than two or more parties on any of the two sides.

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